Negotiations for the release of five British hostages seized in Iraq two years ago tomorrow have been weighed down by complex demands from their kidnappers, a Shia group riven by factionalism.

The group has yet to make its final demands clear, but they are thought to include calls for the release of several high-profile prisoners and political legitimacy in the run-up to next year's election. Members are said to be deeply divided over how best to use their captives, and to be prepared to bide their time.

British and Iraqi officials say that central to their demands is the release of Khais al-Ghazali, a former spokesman for the Shia cleric Moqtada al-Sadr who is being held by the US military in Iraq. Ghazali is accused of orchestrating a lethal ambush of five US soldiers in the Shia holy city of Karbala in January 2007. The US military is reluctant to hand him over to the Iraqi justice system because of his suspected role in the killings.

The US is gradually winding down its detention centre programme in Iraq but wants to hold on to what it regards as a hardcore group of extremists.

Some British officials believe the Britons are being held to use in exchange for Ghazali, his brother Laith al-Ghazali and Ali Mahmoud al-Dakduk, a member of the Lebanese group Hezbollah. The three men were captured together in southern Iraq in June 2007.

The Iraqi government has confirmed that Khais al-Ghazali, who has a strong following among hardline Shia Islamists, is central to a national reconciliation plan. Other officials, with intimate knowledge of the hostage negotiations, say he is a pivotal player in determining the fate of the five Britons.

Mohammed al-Saadi, the chairman of Iraq's National Reconciliation Committee, said the American concerns would not affect Iraq's plans for Ghazali. He said the Shia cleric would play an important role in Iraqi society in future.

"Yes, he can be included in the political process when we receive him from the American side," said Saadi. "He is a very important figure in the political situation. He has a large influence, especially on Shia groups. If he renounces violence and joins us this will be a big success for us."

Saadi said a Shia group called the Righteous League had been in contact with the committee and indicated it wanted a political stake in post-war Iraq. The group released a statement in March claiming that a staged deal for the release of the five hostages was under way. Peter Moore, an IT consultant from Lincoln, was due to be released last in exchange for Khais al-Ghazali. Four security guards who were seized with Moore were supposed to be gradually freed beforehand. No timescale was given.

The British ambassador to Iraq, Christopher Prentice, who has led diplomatic talks with the Iraqi government over the hostages, said today: "It is now two years since five British men were abducted from the ministry of finance in Baghdad. Our thoughts are with them and with their families, as they continue to endure the pain and loss of being separated from their loved ones.

"Iraq is a very different place today compared to two years ago. The security situation has improved and there are real signs of progress, reconciliation and mutual respect as the Iraqi people continue to demonstrate their commitment to a democratic, peaceful and prosperous future.

"The British government remains committed to working with the government of Iraq and anyone else who may be able to bring about the safe release of the men. We appeal to those holding the men to release them so that they may return to their families."